Pros and Cons of Secured Credit Cards
Is a Secured Credit Card Right For You?
One of the toughest times to get a credit card is when you have bad credit or no credit at all. The trouble is, you often need a credit card to start building a good credit history. If you can't get approved for a traditional credit card, a secured credit card is an alternative you should consider.
What's a Secured Credit Card?
What makes a secured credit card different from "regular" credit cards is that you're required to make a deposit to be approved for the credit card. This deposit serves as collateral for the purchases your make using the card. If you default on your payments, the card issuer keeps your deposit. Otherwise, as long as you keep your account in good standing your credit card issuer will return your deposit to you after a certain number of months or when you close your account.
The credit limit on your secured credit card will typically be equal to your security deposit. In some cases, your credit limit can be bigger than your security deposit, depending on the card you choose and your credit rating.
Even though you make a security deposit for credit limit, you can use the secured credit card just like you'd use any other credit card. Swipe it for purchases up to your credit limit and make timely payments toward your balance each month.
5 Good Things About Secured Credit Cards
- You can get approved for a secured credit card when you can't get approved for a traditional credit card. Paying the security deposit shifts the credit risk away from the credit card issuer.
- They typically report to credit bureaus. Unlike a prepaid credit card which lets you make electronic payments just like with a credit card, a secured credit card will your account history to the credit bureaus to be included on your credit report.
- A secured credit card can help you establish or re-establish your credit. Since payments are included in your credit report, paying on time and managing your balance will help improve your credit score. After building your credit score, you may be able to qualify for a regular credit card.
- Your security deposit is used if you default on your payment. Unless your defaulted balance is more than your deposit, you won't get sent to collections for defaulting on your payments. Though the card issuer will keep your deposit, you don't have to worry about debt collectors hounding you for missed payments on the card. (The late payments will still hurt your credit score.)
- You can earn interest on your deposit. Some secured credit cards place your deposit in an interest-bearing savings account. Depending on the interest rate and the amount of time your deposit remains in the account, you might be able to earn a few bucks.
Drawbacks to Using Secured Credit
True, there are several benefits to using a secured credit card, but there are a few disadvantages, too.
- You have to pay the security deposit. It might be difficult to come up with even a couple hundred dollars to make a security deposit. If you do have that money, it might be better spent paying off some outstanding debt. Try setting aside $25 to $50 each month until you've saved up enough for the security deposit.
- There are fees in addition to the deposit. You might have to pay an application fee, processing fee, and annual fee to have your secured credit card. This increases the cost having the card. Shop around and select a card with the lowest fees.
- You may have to pay a higher interest rate. Secured credit cards don't usually offer competitive interest rates because of the risk of default. To avoid high finance charges, pay your balance in full each month.
Is a Secured Credit Card Worth It?
Despite the drawbacks, a secured credit card can go a long way in helping you build a good credit score. When you can't get a traditional credit card, a secured credit card is the best choice for improving your credit and qualifying for a better credit card.